The peak oil story during 2006

One of the first year-end estimates of petroleum production last year (Oil & Gas Journal, December 18, 2006) indicates that worldwide crude and condensate production rose a mere 0.18%, from 72.26 million b/d to 72.39 million b/d.

Petroleum production is reported monthly or annually by various sources: the International Energy Agency, the US Energy Information Administration, the O&GJ, British Petroleum, OPEC, and others. It is reported using various categorizations that can include combinations of the following - crude oil, condensate, natural gas liquids, refinery gains, “unconventional petroleum liquids,” ethanol - or all of the above. When these other figures roll in and are adjusted over the next few months, they will likely tell the same story: flat production, after several years of increases that averaged close to 2% per year.

Key factors behind 2006’s production reality (using O&GJ data): • Depletion continues to overwhelm new production in the North Sea (-9.6%); • Most regions were flat (Asia-Pacific +0.6%, Africa -0.2%, Western Hemisphere -0.4%); • Only Eastern Europe and the Former Soviet Union increased substantially (+4.3%); • OPEC increased 0.7%, though production in Iran and Saudi Arabia declined; Iran has genuine production problems, while Saudi Arabia claims they cut production voluntarily.

So the key question here: have we reached peak production? We maintain that it’s too early to tell. ASPO-USA won’t be surprised if production of total liquids increases moderately over the next few years. However, for that to occur, we would expect that some disturbing recent trends-from geologic limits to nationalism and geopolitics-would have to slow if not reverse. But more importantly, we assert that the combination of difficulties posed by peak oil production are sufficiently challenging that we should act on that information now rather than delaying action based on hopes offered by optimists.

2. Changing patterns of demand

High prices and flat production shifted consumption patterns during 2006. As a group, early data shows that non-OECD nations consumed about 3.8% more (up 1.3 million barrels/day) than they did during the identical period in 2005. By contrast, in the OECD nations, consumption declined at least 1.3%.

Trends in individual countries tell varied stories. In China (#2 consumer) and India (#5), consumption grew unabated. U.S. consumers cut their demand by 1.1%, partly due to a warm heating season and partly in response to record high prices, though demand for gasoline continued growing despite a doubling of prices since 2002. Higher prices squeezed demand hard in some developing nations, from small (Ghana) to large (Pakistan and Bangladesh); a key symptom is the declining reliability of oil-fired electric power generation.

One of the most interesting recent trends - notable consumption growth within oil exporting countries - appears to have continued during 2006, though at this point data is sketchy. This is a trend to watch, since during an era of flat production or slow growth, fast demand growth by exporters will mean less oil available for exports.

Given the two points above - flat production and shifting demand in response to higher prices - it’s possible that the world hit a consumption-driven peak during 2006, similar to the minor two-year decline during 2001 and 2002. Economic clouds on the horizon in the US-from the dollar’s weakness to overall economic performance-could further suppress demand in 2007.

3. Geopolitics and nationalism

The situation in the Middle East and in Nigeria continued to deteriorate during the past year. Increasing sectarian fighting in Iraq and renewed Arab-Israeli hostilities in Lebanon increased the possibility that the Middle Eastern situation could deteriorate to the point where oil exports would be threatened. During the year, Saudi members of Al Qaeda attempted to blow up ARAMCO's vital Abqaiq oil facility. Had they succeeded, Saudi exports would have been seriously reduced.

Nigerian insurgents made progress during the year with as much as 25 percent of the country's production being shut-in by their attacks. In late 2006 the insurgents adopted new tactics, including holding foreign oil workers hostage until the government releases insurgent leaders, and car bombings of foreign oil worker and government compounds. Presidential elections, scheduled for early 2007, offer the prospects of even more political instability.

Rapid oil price increases during recent years have led many oil producers to demand more control over their own oil production and a bigger share of the pie at the expense of international oil companies. Most prominent of the countries moving to gain increased or total control over their domestic oil and gas production during 2006 were Russia, Venezuela, and Bolivia. Over the longer run, reduced participation by international oil companies, who have the capital, management and technical expertise to undertake multi-billion dollar projects, is likely to slow development of many new oil projects.

4. The Great Price Spike of 2006.

Oil prices, on a relatively steady rise since leaving a $28 threshold during late 2003, started 2006 at $61, rose to a peak of $78 during July, only to drop thereafter at a record rate to $55 before finishing the year right where they started ($61). For the year, prices averaged around $67, about $10 higher than during 2005. This was a new high, though still not as high as the inflation-adjusted figure for 1980-81 (variously cited as $85-$90).

When gasoline prices approached and passed $3 a gallon, Congress predictably conducted hearings during which they put the heat on the CEOs of oil majors. Yet when it comes to hunting for culprits, Congress missed the mark by miles. In fact, what some have called the mutual suicide pact between Congress and Detroit, to deflect any and all efforts to mandate higher fuel economy standards, lies at the core of our vulnerability to energy price spikes.

Why did oil prices fall by 25% and gasoline prices fall by almost one-third between the July high and the October low? Several of the explanations probably played a role: lack of hurricanes; gradual return of some offline (Alaska) supply; some notable new supply (Caspian pipeline, offshore Nigeria); record crude inventories; market speculators covering their down side bets; etc. However, any connection between declining prices and the Jack 2 discovery in the deepwater Gulf of Mexico, announced during early September was highly misguided since oil from the Lower Tertiary probably won’t reach U.S. shores for at least a decade.

While ASPO-USA does not offer oil price predictions, we expect to see continued price volatility going forward, with a bumpy but upward trend line for the rest of this decade.

5. Production costs rising

Last year saw a major increase in the costs of exploring for and drilling for oil. These cost increases were so large and came so swiftly that they threaten to slow and scale back oil production projects in the years ahead.

Saudi Arabia's $50 billion program to offset depletion and increase production capacity has resulted in a major exodus of drilling rigs from the Gulf of Mexico. The Gulf’s rig count has dropped from 148 in 2001 to less than 90 today. By contrast, the Saudis now have about 120 rigs in operation. This shift is largely due to the Saudis bidding up the price they are willing to pay for rigs. Rigs that were recently going for $190,000 per day are expected to cost $520,000 per day in 2007. Inflation has pushed the cost of drilling a deepwater well in the Gulf to somewhere around $100 million each.

Cost inflation is also stifling prospects for the Alberta Tar Sands. A Shell project to increase production by 100,000 b/d has had estimated costs increase from $4 billion to nearly $11 billion in recent years. On a per barrel basis, this is six times as much as the first phase of the project cost. Cost estimates for the McKenzie valley gas pipeline that is to supply natural gas for tar sands extraction has increased from $5 billion to $9 billion in recent years. With investment costs like these, extraction from the tar sands may become too expensive to undergo rapid expansion.

Citing the rapid inflation in the cost of producing oil, the IEA estimates that it would cost $20 trillion in new investment over the next 25 years to keep energy supplies up with demand -- assuming the oil was available.

6. Change in the Congress

By Election Day, the great summer price spike of 2006 was over. Gasoline prices were back down to circa $2 again and energy costs were far from the voters' minds when the entered the booths. However, given the steady deterioration in the Iraqi situation and no obvious way out, it wasn’t surprising that voters called for a change in national leadership.

Prior to the Democratic victory, the basic US energy policy had been to increase domestic oil and gas supplies by giving tax breaks to oil companies and easing environmental restrictions on drilling; converting corn surpluses to ethanol; and spending some money for R&D on future energy sources. Although the new Congress has not yet met, early indications point to changes in the offing.

The new Democratic House leadership is already talking about rolling back tax breaks for oil companies, probing off-shore lease deals, providing more money for renewable fuels, more diesel and electric cars, and settling the spent nuclear fuel issue. Even the Bush administration got into the spirit by announcing they would soon launch a major "energy independence" initiative to include increased emphasis on developing cellulosic ethanol.

On the Senate side, incoming majority leader Harry Reid said Congress needs to move investment away from fossil fuels and toward solar and wind power, geothermal, and biomass. "We can't do it overnight but I think we have to set goals." Reid says he favors raising fuel economy standards, which the industry is against. He also says he'd be open to new nuclear power in the U.S.

Although there are many dark clouds on the horizon, at the moment the nation's energy situation is relatively benign. By recent standards, prices are manageable, stockpiles are fine, and the hurricane season is still six months away. For the time being there is little incentive for the new Congress to make radical changes in energy policy. Increased emphasis on conservation and renewables certainly can't hurt and in the long run is the proper way to go.

The real test, however, will come when for whatever reason -- war, terrorism, hurricanes, or simply oil depletion overcoming new production -- prices start moving to new highs and shortages develop. It will be up to whatever party is in power to meet this challenge with meaningful policies that will start to move the nation towards a new energy era.

7. Europe has a problem.

Last year began with a European energy crisis caused by Russia's cutoff of gas supplies to the Ukraine over a pricing dispute. Because Russian gas passes through Ukraine on its way to Western Europe, the pressure also dropped in Paris, Vienna and Rome. Europeans suddenly realized they were dependent for electricity and warmth on a Russian government that was prepared to use energy as a tool of diplomacy.

The Russian-Ukrainian gas price dispute, a cold snap in January, heightened tensions surrounding the Iranian situation, and the cartoon cultural clashes have combined to increase European awareness of their growing economic vulnerability to unreliable energy supplies. Rapid declines in North Sea oil and natural gas production have left Europe increasingly dependent on oil and gas imports. In 2005, Europe imported 56 percent of its energy requirements and is forecast to be importing 70 percent by 2030.

Throughout 2006, the EU tried to engage Russia in discussions about their long-term energy relationship, but as the world's largest oil producer, Moscow is doing extremely well from the new higher oil prices. Soviet-era debts have been paid off and Russia is finding it easy to borrow against its increasing petro-wealth on the world's capital markets. In short, Moscow is coming to believe that Europe needs Russia more than Russia needs Europe.

During 2006, Russia took steps to effectively renationalize foreign oil projects inside its borders and is refusing to let natural gas transit its territory without some form of control. Moscow also started on pipelines to the Far East, positioning Russia to export to China and other Asian markets. To make matters worse, a report was released during the year suggesting that Russia has not been making sufficient investments in exploring for new gas production so that its ability to continue exporting large quantities of natural gas may soon start to decline.

All this bad news has made Europeans very nervous. The EU's Energy Commissioner said that the organization has begun work on a common energy policy, conservation and renewables, and warned that Europe faces a major energy crisis in the next 20 years unless something is done.

8. Droughts, storms, and global warming

During 2006 we saw increased recognition of the complex interrelationship among fossil fuels, global warming, damaging storms and more recently the shrinkage of world fuel stocks. As average worldwide temperatures increase, traditional weather patterns are changing in unpredictable ways. During the past year, large sections of the world suffered from unprecedented drought conditions. These droughts reduced food production, emptied hydroelectric reservoirs, and even blew so much dust over the Middle Atlantic that the formation of hurricanes was suppressed during 2006.

On the up side, warmer temperatures have reduced the need for winter heating fuels, but have increased the demand for summer air conditioning in the richer parts of the world. Furthermore, in some regions reduced hydroelectric production coupled with unaffordable fuel oil for power generation has forced many nations to reduce the demand for power through rolling blackouts.

To combat higher oil prices, the Chinese are turning increasingly to coal. They plan to build 500 more coal-fired power stations, adding to some 2,000, older plants that spew smoke, carbon dioxide and sulphur dioxide. The situation is so far out of control that Beijing only recently discovered that Inner Mongolia had built without permission 10 new power plants totaling 8.6 gigawatts. Chinese coal output has doubled in the past five years. China is on course to overtake the US by 2009 as the world's largest emitter of carbon dioxide.

Until recently the Chinese, and many others, believed that any program necessary to support rapid economic growth was a good thing. Beijing resisted calls for a cap on emissions growth, arguing that most carbon dioxide in the atmosphere was produced by developed nations that have no right to deny rapid economic growth to China. However, Chinese thinking about emissions is changing. A forthcoming official report of global climate change impacts on China will warn of worsening drought in northern China and increasing "extreme weather events". The flow in China's Yellow River currently is running 33 percent below average due to drought and high temperatures.

Chinese President Hu Jintao recently called for intensified efforts to save energy. He advocated using price, tax and other financial measures to promote energy saving and curb wasteful use, and said industries that consume excessive energy and pollute the environment should be shut down. China, the world's fourth-largest economy and second biggest energy user, has set a goal to cut energy consumption per unit of national income by 20 percent by 2010.

It also appears that China is finally making the connection between the burning of fossil fuels and food production.

9. Recognition of peak oil in 2006

Public and governmental recognition that the peaking of world oil production may indeed be imminent made little progress during 2006. The year started out with the State of Union address in which President Bush declared that the country was addicted to oil and that we need to switch to renewables. The context of the President's declaration, however, was concern over dependence on foreign imports that could be shut off in a crisis and not worldwide oil depletion.

In March, the New York Times editorial board declared that the concept of peak oil was "almost certainly correct" and that the world would indeed run out of oil someday. In order to be even handed however, they balanced concerns about imminent peaking with government estimates of 2027 or 2037 and failed to take a stand on just when peak oil production would occur.

During the first half of the year, as oil and especially gas prices were soaring to new levels, most expressions of concern had to do with various forms of conspiracy or price gouging. By August, however, the prospect of damaging hurricanes receded, the Middle East calmed a bit, and hedge funds began unwinding long positions. Prices underwent a precipitous decline from the mid-$70s per barrel to a bottom around of around $55. A number of financial analysts seized the opportunity to declare that the peak oil theory was now dead, gone, and discredited. Then came the Jack-2 announcement.

Jack-2 is an ultra deep test well in the Gulf of Mexico. When Chevron announced that the well had just been tested at a rate of 6,000 barrels per day, some of the media had a field day pronouncing the energy crisis over.

On September 7, 2006 Business Week wrote “Plenty of Oil-Just Drill Deeper,” and “You can tune out all the scare talk about Peak Oil for a while--probably a long while.”

Exxon and Saudi ARAMCO executives continue to make speeches claiming that imminent peak oil is simply wrong. In the fall Cambridge Energy sold a report claiming that oil production will grow for decades. The report was accompanied by yet another barrage of press releases against peak oil.

The major lesson from all this seems to be that acceptance of the idea of imminent peak oil has a lot to do with the price of gasoline. As new highs are reached, those who have heard of peak oil tend to get worried. If gasoline slips back to $2, it was all a bad dream.

Two "official" government studies, which are to investigate the reality of imminent peak oil, are due out in the next few months. What they say and what sort of media coverage they receive may determine much of the media's and governmental perception of peak oil until prices become really high.

10. The Rush for Substitutes

The year 2006 saw a substantial increase in the call for and development of substitute fuels. ASPO-USA notes that this very push for substitutes is quite possibly a sign of a growing unspoken understanding of the impact that peak oil could have in our near future.

The near doubling of corn-ethanol fuel production, as directed by National Energy Policy Act of August 2005, is proceeding well ahead of schedule thanks to an ethanol “gold rush” of sorts. Yet what will the doubling accomplish? Compared to the 20.5 million barrels a day of petroleum liquids we consume each day, ethanol made by converting 15% of our corn crop to ethanol provides only 1.7% (about 350,000 b/day) of our liquid fuel consumption. Given the impacts on land, the coming increases in food costs, plus the escalating use of natural gas and coal for process energy, the future benefits of obtaining the projected 3% of our fuel from ethanol from corn were increasingly debated.

Leases of small acreages of western lands for oil shale, again as directed by the NEPA, were approved last year, yet for a host of reasons recipients will be very unlikely to produce any measurable amount of liquids (say 100,000 b/d) by 2015. Year 2015 production from the coal-to-liquids process could exceed the 100,000 b/d level, thanks to growing interest from the Department of Defense last year, but the thermodynamic, environmental and dollar costs of this potential source of liquids raise serious questions. Investments in further production of liquids from tar sands are now expected to lag behind projections (see #9 above).

For 2007 and beyond, the major untapped energy resource remains energy efficiency. By 2015, upwards of 1.5 million b/day could be saved simply through an urgent national commitment to very efficient vehicles.

Energy Briefs for the week of December 25th

• Russia and Belarus announced a last-minute deal on gas prices, moments before Moscow was to start cutting off supplies with potential disruption for customers in Europe.

• According to an analysis published by the National Academy of Sciences, Iran is suffering a major decline in revenue from its oil exports, and if the trend continues oil income could virtually disappear by 2015.

• Iran's oil industry is suffering from US pressure. "Iran has been under different sanctions for years and many companies have not been able to cooperate with our country for fear of US pressures," Iranian Oil Minister, Vaziri Hamaneh said last week.

• China's crude imports for 2006 will increase 10 percent over 2005. Total crude oil production is expected to increase by only 1.8 percent. A senior official from the Ministry of Commerce told Xinhua News Agency that robust GDP growth had forced China to depend more on imports because of limited domestic production.

• Abu Dhabi's state oil firm says it will cut some crude sales in February by 3-5 percent, the first indication of an OPEC member applying new output curbs.

• Canadian natural gas exports to the United States could fall by about 10 percent from current shipments. The cuts would come as a result of reducing drilling and increased demand from the tar sands boom.

• The falling US dollar is pushing the United Arab Emirates to convert 8 percent of its foreign exchange reserves into euros. The Emirates' nearly $25 billion currency reserves are currently 98 percent dollars.

• In India, the Hyderabad state government initiated a daily four-hour power cut to help with the ongoing energy crisis in the state. Farmers are protesting there is not enough electricity for their irrigation pumps. Pakistan has closed four power plants due to scarce supplies of natural gas.

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